Muni Credit News Week of November 6, 2017

Joseph Krist




This week we focus not on a bond transaction but on what truly will the issue for the municipal bond market – tax reform. The proposal or framework that was laid out this past week for how to “reform” the tax code is a potential watershed event for our market. The numerous provisions regarding municipal bonds included in the proposal came as a real surprise to market participants. The state and local tax deduction has actually been on the table for a while. But the provisions eliminating private activity bonds, the alternative minimum tax, and advance refundings were all unexpected. We argue here that individually and in total, they represent a narrow minded philosophy which contradicts basic beliefs espoused by both the president and the congressional majority party while making it much harder for the needs of those who voted for them less achievable.

Tax reform at its best would be undertaken for the purposes of simplicity, fairness, and stimulation of the economy. It would not be undertaken to fulfill narrow partisan interests. The House bill is clearly a political document meant to be a sop to the wealthiest in the country, those who benefit from their ownership of business rather than the providers of its labor, those who hate local government, and those who believe in a more regressive tax system. It is the manifestation of the “starve the beast” philosophy against government at all levels.

We do not argue here that government is the most efficient provider of services but we do believe in the idea that some of those services are most rightly classified as public goods. That is not inconsistent with a belief that private entities have a real role to play in the provision of public services. What we are somewhat astounded by is the lack of support for private participation in the efficient provision of public goods which is reflected in this bill. Our amazement is based in the espoused philosophy of the President and the majority especially as it pertains to the renewal and development of the nation’s infrastructure.

We acknowledge that each of the targeted provisions which impact the municipal bond market have and can be the subject of abuse. We applaud for instance the proposals which would end public funding for stadiums. But we question the basis for limiting the options available to government to finance infrastructure that are inherent in the proposed bans on all private activity bonds. We question whether the reductions in revenue associated with the corporate tax cuts that will make it harder to finance projects of national benefit (mass transit, interstate transit, airports and associated facilities, environmental control at private industrial facilities) are worth the price.

The limitation on the deduction for state and local taxes to property taxes only will increase the reliance on more regressive taxes like property to finance basic local services especially schools. In so many jurisdictions, property taxes especially for schools are the greatest source of local discontent. Economics 101 questions the efficacy of taxation based on perceived wealth rather than income. It increases pressure on first time homeowners and the elderly. It does that at a time when state and local government potentially face issues from the majority party’s belief in block grants (which always represent reductions) to finance federal aid. These reductions will impact service delivery especially in areas like health and social services which have greater impact on the less fortunate segments of society. That pressure is a major credit negative for state and local tax backed credits.

The Administration and many in the Congressional majority favor a greater private role in the provision of infrastructure. Exactly how does the elimination of private activity bonds achieve that goal? It doesn’t mean that the private sector can no longer participate but by raising the cost of capital it makes projects more expensive for end users while making it harder for private vendors to achieve their desired rates of return on capital. That is true even if those rates of return are reasonable. And if the returns are low will the private sector want the government participant in these projects to assume more of the development risk? If so, that is another source of increased risk to government which will further hinder the development of necessary infrastructure.

Finally, there is the issue of whether the proposed package which by all accounts benefits the wealthiest taxpayers relative to others will indeed achieve the job growth projections which have been cited as the overarching reason to accept the clear weaknesses of this proposal. Unfortunately, history tells us that it will likely not based on the quantitative facts available.

History is instructive as to whether this was indeed the case with the Reagan and Bush tax cuts. In the immediate years after the Reagan tax cuts, average weekly wages for rank-and-file workers (non-supervisors) went from $285 a week in the autumn of 1986 to $282 a week in October 1987, according to Labor Department statistics that are adjusted for inflation. Average weekly wages hit $271 a week by 1990. After the Bush tax cuts, median real wages actually dropped from 2003 to 2007. Household income from business-cycle peak to business-cycle peak declined for the first time since tracking started in 1967. This was followed by the Great Recession. In both cases, the federal deficit exploded which contributes to larger borrowing requirements competing with the financing needs of state and local government and businesses.

Proponents such as the President are trying very hard to show that the plan is a job and income creator. The President cited the concurrent announcement of the tax cut with that of plans for Broadcom, an electronics manufacturer, to “return” its corporate headquarters to the US. He cited revenue forecasts (confusing that with income) to tout the increase to the tax base which would support his plan. In fact, Broadcom already physically has it headquarters in San Jose, CA. It is legally domiciled in Singapore and that legal domicile is what will be returned to the US through incorporation in Delaware. Apparently, this decision was already made before the tax plan was announced and obviously before enactment. The reason for the relocation likely has nothing to do with the US tax plan.

Currently, the government of Singapore give Broadcom tax breaks which facilitated its domicile there.  Recently, it was announced that Singapore would end those tax breaks four years earlier than expected. Broadcom is also pursuing the acquisition of a US company and that transaction is subject to, and threatened to be held up by, a legally required review of the takeover by a foreign based company which derives some 40% of its revenue from China. The “relocation” to the US would stop that review without changing any of the other characteristics of the company.

So what would the net result be for states and municipalities by this plan? Less revenue (unless significant decoupling of state tax schemes from the federal scheme occur), a greater share of costs for many basic services, a higher cost of borrowing, less flexibility in infrastructure development, less financing flexibility during times of declining rates (which is a reflection of diminishing economic activity), and a reduced ability to maintain existing infrastructure especially in areas like health and the environment.

All in all a stunningly comprehensive attack on the funding of basic government responsibilities likely to contribute to a less functional and more slowly expanding economy.



According to a feasibility study awaiting review by Gov. Eric Holcomb, there is an 85 percent chance that revenues would exceed $39 billion from 2021 to 2050 by converting six Indiana interstates into toll roads. The estimates were prepared by HDR Inc. for the Indiana Department of Transportation, which was assigned to do the feasibility study by the Indiana General Assembly this past session. HDR was to examine the feasibility of tolling six Indiana interstates.

The revenue predictions do not account for the costs of toll collections or insurance. However, INDOT would be encouraged to explore the use of electronic tolling so drivers would not need to stop or slow down. The state would need to build about 370 devices that house cameras to capture transponders and license plates, costing about $1 million. The analysis was based on an INDOT economic model assuming that passenger vehicles would pay 4 cents per mile; light/medium trucks would pay 6 cents per mile and heavy trucks 19 cents a mile.

Among other claims in the study – “Tolling paired with widening I-65 and I-70 and a decrease in fuel taxes over time could increase Indiana’s Gross State Product by almost $27 billion.” While I-65 would become the largest revenue generator — up to $16.2 billion — it could also see a 10 percent decrease in traffic along its 261-mile northwest-to-southeast route due to tolls. In the case of I-65, the $16.2 billion figure comes with 50 percent confidence level.  A tolling system along I-69 could raise between $8.4 billion (85 percent chance) to $11 billion (50 percent chance). Under the same levels, tolls along the east-west I-70 could likewise produce $6.9 billion to $9.1 billion. Similarly, I-74 could bring in $3.2 billion to $4.2 billion.

The state would need to build about 370 devices that house cameras to capture transponders and license plates, costing about $1 million. The analysis was based on an INDOT economic model assuming that passenger vehicles would pay 4 cents per mile; light/medium trucks would pay 6 cents per mile and heavy trucks 19 cents a mile. “This is a feasibility study, designed to inform discussions about the feasibility of a statewide tolling program. This study is not an investment-grade study that can be used to secure financing for a tolling project,” the study said.


The troubled Chicago Board of Education credit received positive news in the form of an outlook revision to stable from negative from Standard and Poor’s. The Board’s general obligation bonds remain rated B. The outlook revision reflects the district’s higher state aid revenue as a result of the state’s new funding formula, and lower pension costs, with the state now picking up more of the employer pension contribution, and the district’s ability to extend a higher property tax levy to support the pension contribution. These were a result of the FY 2018 state budget accord.

In July 2017, bond proceeds were used to reimburse the district for swap termination payments and capital expenses, and to pay for near-term debt service expenses, which improved the district’s cash position. The credit still exhibits extremely weak liquidity and its vulnerability to unexpected variances in its cash flow forecast. The district has shown an ability to weather unexpected obstacles such as the increased delays in block grants from the state in fiscal 2017, and City of Chicago officials have indicated a willingness to provide the district with limited financial help if needed. But the district’s cash flow was worse than budgeted in fiscal 2017, and the potential for the state’s own financial problems to negatively affect the district remains an issue.


The House approved the CHAMPIONING HEALTHY KIDS Act of 2017 (H.R. 3922), legislation that includes a five-year extension of funding for the Children’s Health Insurance Program and two years of relief from Medicaid disproportionate share hospital payment cuts. Among the CHIP provisions, the legislation specifies that funding for the federal matching rate would remain at 23% through fiscal year 2019, change to 11.5% for FY 2020 and return to a traditional CHIP matching rate for FYs 2021 and 2022. In addition, the bill would eliminate $2 billion in scheduled Medicaid DSH reductions in FY 2018 and $3 billion in reductions in FY 2019.

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